Differential Analysis

Running head: DIFFERENTIAL ANALYSIS
Differential Analysis
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1DIFFERENTIAL ANALYSIS
Differential analysis helps us in understanding the cost components and cost comparison
of various options available. It explains the relationship of avoidable and unavoidable cost with
the production volumes and production related activities. In this paper, a case study on such a
differential costing has been analyzed to understand the topic in a better way (Kaplan &
Atkinson 2015).
The main objective of a differential analysis is to find the differences in total costs in
various production options or activities. In doing so, the cost components need to be identified
carefully and their relationship with the total cost must be identified. Cost components must be
classified in variable, fixed and semi variable components, to run a differential analysis
effectively and efficiently. In this process, identification of cost in terms of avoidable and
unavoidable is also important. Purely variable expenses are related with some activities, if that
activity is not used, there will be no variable costs related to that activity. It proportionately
increases with the increase in production volume and decreases with decrease in the volume of
production (Margolies & Hoddinott 2015). Therefore, variable expenses or costs are fully
avoidable in nature. It comes to a complete zero if the production is stopped. Every production or
manufacturing systems have some fixed expenses also. Fixed costs are rigid in natures. It occurs
irrespective of the volume or level of production. As fixed costs are incurred for the whole
business process, there may be certain parts of fixed costs, which can be reduced to certain
extent, and that part of fixed cost is known as the avoidable fixed costs (Ward 2013).
Having the knowledge of those cost components, the differential cost analysis can be
started. In the given case study, the company is having two options, they can produce the
subassembly using their in-house production system, or they can purchase the component from
an outside supplier. There are four parts of the total cost of producing the subassembly. It